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Remarks of Tony Tyler to UK CAA Board at the Hearing Concerning the Regulation of Heathrow Airport, London

Dame Deirdre and Board Members,

On behalf of the airline community at Heathrow, representing 91 airlines in total, I would like to thank you for the opportunity to speak today at this very important hearing concerning the future price and service standards at the airport.

I would also like to thank the CAA’s regulatory policy team for all their efforts over the last 18 months in establishing the Constructive Engagement (CE) phase of the CAA’s Q6 review.

I cannot overemphasize the importance of the right decision coming from this process - one which must require much tougher cost control for the airport. But for this introduction, I want to make it clear that this is not just about airlines pushing for short- term charges reductions at Heathrow - the issues are far broader and concern the longer-term strategy for the airport.

New approach

Firstly I am very pleased that there has been a fresh approach by the CAA to the Constructive Engagement model. For example we welcome the inclusion of operational costs of the airport within the scope of the Constructive Engagement.

The airline community has also welcomed the CAA’s open door policy and the opportunity to address complex issues with a high degree of transparency and scrutiny. These efforts culminated in the joint Constructive Engagement report of the airline community and Heathrow airport, published on the 3th December, and forms much of the basis for the case we are here to present today.

Our thinking is continuing to develop and I will leave the detailed discussion on the key issues, many of which are documented in terms of agreement and disagreements, to the question and answer session.

New Mandate

The adoption of the new Civil Aviation Act strengthens the priority of the CAA with regard to the interests of the passenger. We very much welcome this new mandate. The airline community recognizes the passenger as the customer and we operate in a very competitive market to ensure that our products meet the customer’s requirements in terms of price and quality.

We have recently seen the impact when an airline does not meet its customer’s requirements: BMI, the second largest operator at Heathrow, sadly, no longer exists and illustrates the difficult economic circumstances which all airlines are facing today.

Both cost control and quality control are essential if airlines are to survive in a highly competitive market. But such critical decisions cannot rest solely with airlines. As a key stakeholder, airports must also make the necessary commitments to improve both cost and quality control – in the best interest of the passenger.

New Challenges

These challenges are magnified in the case of Heathrow airport. Our firm view is that the lack of an effective approach to cost control by Heathrow airport has resulted in it becoming one of the most expensive airports for airlines to operate at.

All the evidence shows the same result: the cost per passenger will have risen from £7.34 in 2004/5 to over £21 in 2013/14.

In fact, prices will rise, on average, by 18.9% for 2013/14 alone.

I’m sure I do not need to elaborate on the stark difference between these increases and the economic reality facing airlines and passengers. We have reached a tipping point at Heathrow and the previous approach in which Heathrow airport was allowed large annual increases in charges is no longer sustainable.

Neither are such increases necessary:

Airport OPEX has risen from under £500m before Q4 to an estimate of £1.2B at the start of Q6 – that’s an increase of 140%. During this time, there has been little traffic growth. We determine there to be substantial savings potential in OPEX – in fact over £ 1billion throughout Q6.

The airport’s calculation for the cost of capital for Q6 uses an equity beta of 1.3 which means it considers itself 30% more risky than the equity markets – surely this needs correction.

The commercial revenue is under-forecast by £150m caused by various factors one of which is unrealistic passenger numbers – reduced by a “shock” factor which we disagree with. There is also the lack of challenge in leveraging their position as the highest yielding commercial airport.

Airlines and passengers should no-longer be asked to pay for the airport’s inefficiency and carry undue risks for the airport’s business.

As a result we have, as a united community of airline users of the airport, carefully defined potential improvements to the airport’s proposals. This is a result of a critical assessment of capital expenditure plans, operating costs, commercial revenues and fair returns for the airport.

Our current assessment demonstrates the potential for a price cap significantly below RPI and I sincerely hope the CAA will support us in this challenge. A price cap significantly below RPI is achievable and will allow an investment program of £3 billion if robust but necessary OPEX, WACC and commercial targets are determined by the CAA.

In addition, airlines have also developed a priority capital expenditure plan which will allow for flexibility in the size of capital investment according to the regulatory settlement. To summarize, the airline users at Heathrow are unanimous – urgent action is needed to ensure the affordability of operations at the airport.

Maintain Service Quality Standards

For Heathrow to become Europe’s hub of choice, the priorities of the passenger and the airlines need to be fully integrated and embedded in the service quality regime under the direction of the CAA.

The existing standards provide a baseline to deliver and measure quality from a passenger perspective. These have stood the test of time since Q4 and the overall framework needs to be retained. Some standards, particularly, around security functions will need to improve and we are currently working with the CAA.

I would like to emphasize that maintaining quality standards in Q6, to at least the level in Q5, is necessary for the benefit of passengers. But this does not mean there is little scope for cost improvement. Existing cost, process, and resourcing in-efficiencies must be driven out of the system. The evidence collected during Constructive Engagement process indicates that substantial productivity gains are possible (£1 billion in savings throughout Q6 as I already mentioned) and this can be done whilst maintaining at least Q5 service levels.

Hub capacity and resilience

We are all aware of the capacity crunch in the UK and the operating constraints at Heathrow, the UK’s only hub airport, which as you know is 99% full. I eagerly await the early recommendations of the Davis Commission and I will urge the UK Government to get a grip on the policy paralysis before the next election.

In the meantime we recognize the importance of the “Operational Freedom” Trials at Heathrow. My members will welcome the early implementation of new and permanent operating concepts at the airport. This will strengthen the resilience of the current operation and ensure the swift recovery of the schedule following weather related disruption experienced recently.

In addition, the CAA’s own Future Airspace Strategy (FAS) will play a leading role in restructuring by modernizing the complex airspace around Heathrow. This will secure much needed fuel, noise and emission benefits by eliminating the need to stack aircraft. I would like to compliment the CEO CAA, Andrew Haines, and his team in moving the project into the deployment phase as part of the UK’s contribution to the Single European Sky and the SESAR project.

IATA is committed to these projects but we must ensure that Q6 Capital program is results-based and delivers the benefits without delay. My members are purchasing many large bodied aircraft which may help to overcome some of the capacity constraints at Heathrow. However larger aircraft require a higher safety separation standard and, potentially, a reduced flow rate. A far more flexible operating environment is essential if the integrity and punctuality of the current schedule is to be maintained.

To conclude, airlines are committed to delivering excellent service for our customers – the passenger – and the need to improve hub capacity and resilience at Heathrow. But we can only do this at a price which the customer willing pay and is affordable to our operations.

The evidence shows that Heathrow is inefficient when benchmarked with other airports and that affordability has to be the key driver for the Q6 settlement. The airport operator must be subjected to the same cost control discipline as is applied by the airline industry itself: and this is possible without compromise to service quality or investments. We determine that a price cap significantly below RPI is readily achievable and will allow an investment program of £3 billion if robust OPEX, WACC and commercial targets are determined by the CAA.

I thank you listening and I know that you will have many questions which we will be happy to answer.